The sharp drop in oil and natural-gas prices has produced an even sharper pullback in energy stocks, creating what may be one of the best buying opportunities in the sector in several years.



THE SHARP DROP IN OIL AND NATURAL-GAS PRICES HAS produced an even sharper pullback in energy stocks, creating what may be one of the best buying opportunities in the sector in several years.

Energy issues have rarely been so inexpensive, relative to oil and gas prices, estimated asset values and earnings. Barring a collapse in oil and gas, energy could prove to be one of the market's top groups over the next year. Most of the stocks could easily rise 25% or more.


Justin Sullivan/Newscom
Even though gasoline prices have slipped from where they were when this picture was taken a few weeks ago, they're likely to remain high.
It's hard to find a sizable energy company that's trading for more than 10 times next year's estimated earnings. As the table below shows, the major oils -- ExxonMobil (ticker: XOM), Chevron (CVX), BP (BP) and ConocoPhillips (COP) -- now fetch five to seven times next year's projected profits. The majors have rarely had such low price/earnings ratios.

The projected 2009 profit estimates could prove too high, of course, given the 22% drop in oil prices to $115 a barrel from a peak of $147 on July 11. Natural gas has fallen even more sharply, declining 35% to $8.50 per million BTUs from a July high of over $13.

The stocks, however, seem to be discounting a drop in oil to well below $100 a barrel, and a skid in gas to as low as $6 per million BTUs. Energy shares have badly trailed commodity prices. The XLE (XLE) -- the exchange-traded fund for the S&P 500's energy issues -- is up just 6% over the past year, while oil has risen 66%.

Investors have several ways to play energy, including the major international oils, independent domestic producers and Canadian energy outfits.

"THIS HAS BEEN ONE OF THE SHARPEST CORRECTIONS ever in E&P," says David Kistler, an energy analyst at Houston-based Simmons & Co., which focuses on independent North American energy and production stocks. "Nearly every stock screens with tremendous valuation upside." Simmons estimates that major independents like Anadarko Petroleum (APC), Devon Energy (DVN) and XTO Energy (XTO) now trade at little more than half their net asset values. Kistler views the independents' risk/reward ratio as excellent.

The independents benefit from growing production bases heavily tilted toward North America, shielding them from Venezuelan-style expropriation, Russian strong-arming and the general shift in the balance of power to host countries and state-owned companies.